Thursday, August 16, 2007

The global pyramid scam

After a week of attempts by central banks to resuscitate global financial markets by injecting cash, the contagion continues to spread around the world, driving stock markets sharply lower. As is the fate of all pyramid-selling scams, the global economic structures built upon an addiction to credit and its inseparable opposite debt, are unwinding fast with devastating impact. Adding to the current crisis is the fact that financial institutions are now scared of each other. No one really knows the level of exposure each investment and commercial bank holds. As a result, inter-bank trading has ground to a halt because no one wants to be left holding the debt hand grenade when the music stops.

Central banks have been trying to restore confidence, with the Bank of Japan announcing on Thursday that it would inject a further 400bn yen ($3.4bn) into its banking system. The US Federal Reserve made another $7bn (£3.5bn) of reserves available to the banking system on Wednesday. The Fed has injected $71bn into the system since 9 August. However, such moves, along with comments by US Treasury Secretary Henry Paulson that the economy was strong enough to withstand the turmoil, have done little to appease investors.

The current market volatility has been triggered by the US sub-prime mortgage sector, which offers higher-risk loans to people with a poor credit history. This particular bubble has burst as a result of higher US interest rates combined with falling house prices. The number of people defaulting on their loans has soared. While some estimates say $300bn in loans could be at risk, the eventual scale of the problem is thought to be much greater. The original loans were sold on as debt by mortgage companies to other institutions, who in turn have loaned out money against the expected income. Yesterday the situation worsened after Merrill Lynch told its clients to sell any shares they own in the country's largest mortgage lender, Countrywide Financial. It warned that Countrywide could face bankruptcy if the availability of credit in the market gets any worse and there were market rumours that the lender had failed to raise some money it needed.

No less devastating are the extremes of weather which are linked to climate change, itself a product of over-producing global, capitalist corporations whose products are largely bought on credit. Events in and around Wall Street on, August 8th, little reported in British media, provide a striking illustration of the intimate connection between the turmoil in the markets and wild climate. Hours before the financial storm broke, the Financial Times investment editor was commenting that futures and stock markets “reflect a belief that crisis will be averted. Both are vulnerable to bad news from the credit market. Once Wall Streeters calm down after their commute from hell, that will again be their greatest concern”. That morning a fierce morning storm disrupted transport throughout much of the region and unleashed a rare and destructive tornado that whipped the area with winds of up to 135 miles an hour, dropping 3 inches of rain on the New York metropolitan area in about an hour. Whilst there has so far been little attention to the direct impact of the Brooklyn tornado on the next day’s panic trading across the bridge in Wall Street, both are clear signs of a system in crisis, even meltdown.

Gerry Gold, economics editor

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